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With Normal Weather, Consultants Expect Gas Price Correction to Continue into 2006

If this winter ends up with a normal number of heating degree days (HDDs), natural gas storage should be tighter than last year but still well above 10-year norms, an energy consultant said last week. That realization seemed to resonate across the market as the Energy Information Administration (EIA) reported a lower-than-expected 162 Bcf storage withdrawal on Thursday. January futures crashed $1.348 on Thursday and then collapsed another 64 cents Friday to end the week at $12.283.

Mississippi-based energy consultant Stephen Smith said he expects to see further erosion of the gas-to-residual fuel oil cash price spread ($5.40/MMBtu on Dec. 16). If the spread were to hold in the range of $5-7/MMBtu, "it would extend recent demand destruction trends throughout the first quarter, thereby causing a much stronger storage surplus growth" than indicated by his base case.

"If HDDs and the restoration of hurricane gas shut-ins follow the base case scenario...then we would estimate a year-end gas-to-residual spread of $4-5/MMBtu. Assuming a year-end resid price of $7.50/MMBtu, this would yield a year-end Henry Hub cash price (or January bidweek price) of $11.50-12.50/MMBtu. By April bidweek, our estimate is for Henry Hub in the $8-10/MMBtu range (with a likely spread of $1-2/MMBtu)."

With moderating temperatures through the holiday weekend, John Gerdes, a Houston-based energy consultant, is forecasting an 8% sequential decrease in total degree days (TDD) through the week, which should lead to lower power demand. TDDs of 207 in mid-December were 8% lower sequentially, 57% higher year-over-year and 27% above the long-term range, he noted. Gerdes is forecasting gas prices will slowly correct over the next few months and average $8.90/MMBtu for 2006.

The Energy Information Administration (EIA) appeared to concur with at least some of the analysts' forecasts. In its recent annual outlook issued earlier this month, EIA said gas prices would decline in the near term, but longer term they will increase, causing gas to ultimately lose power generation market share to coal and nuclear (see NGI, Dec. 12).

Even if the high gas prices don't last through the winter, exploration and production (E&P) stock prices will likely uptrend in 2006, Smith noted. In his December "Monthly Energy Outlook," Smith used a six-year frame of reference to explain his take on E&P performance, which indicates typical share prices for E&Ps have increased by about 275% over the time period. There have been dips, and even "near vertical" drops, like in October, when investors reacted to the devastating storms in the third quarter -- "a convincing demonstration as to how rapidly 'implied sustainable oil/gas price expectations' can change."

Still, he wrote "psychology and momentum play an enormous role in pricing energy shares, and it is possible that a sustainable gas/oil price level in excess of $7/MMBtu could be at least temporarily 'priced in' to the E&P shares before this multi-year bull market tops out." Before next summer, however, Smith is expecting the E&P bull market to return.

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